This trade case and its various aspects is one of the most cited
and published in U.S. trade history. It has drawn a high level of
attention due to a number of unique events, the terms of the three
agreements, and global industry outcomes. Because of these elements, the
U.S.-Japan Semiconductor Trade Agreements (1986, 1991, 1996) have been
the subject of numerous short cases at various points in the overall
20-year period of U.S.-Japan trade conflicts in semiconductors. These
new cases, presented here, cover the entire period in four parts (A, B,
C, Epilogue). The case presentations follow in chronological order.

U.S.-Japan
Competition and Trade in the Global Semiconductor Industry

CASE
A (1977-1986)

I.
The Critical Events

For nearly three decades following World War II, the United
States reigned supreme in all high-technology and knowledge-based
industries, including electronics. But by the mid-1960s this began to
change, and by the end of the 1970s, the Japanese had replaced American
firms as the dominant firms in the U.S. consumer electronics market. The
production and sale of products such as television, video games, and
radios, all came under the domination of Panasonic, Nintendo, Sony,
Matsushita, and other Japanese manufacturers. And the threat to American
manufacturers in the various fields of electronics products did not stop
with consumer products.

Since it was believed that the dominant Japanese
electronic products manufacturers obtained chip components from their
internal suppliers, who were also members of their keiretsu¾vertically aligned systems of business
relationships¾the loss of
American consumer electronics manufacturers also meant a loss of
American semiconductor markets for American chip producers. Furthermore,
this resulting increase in Japanese chip production would also be the
basis for a more competitive Japanese supply of chips to other world
electronic products markets with potential future losses to American
firms in these markets. Although the threat of even more intense
competition from Japan was quite apparent to industry analysts, few at
that time could expect that the fiercely competitive entrepreneurs of
Silicon Valley, California, would for the next two decades seek the
assistance of the federal government to engage in a long, drawn out
political battle with their Japanese competitors.

Although they understood well the conditions that
were driving changes in their industry, the independent-minded CEOs of
American semiconductor and equipment manufacturers were divided along
lines separating their respective economic interests. Merchant chip
makers, captive chip producers, semiconductor production equipment
makers, and computer systems companies each had their own different set
of interests that they voiced to various agencies in the U.S.
government. Complicating things further, these various government
agencies had their own concerns as to the degree of impact that the
relative positions and policies of the United States, Japan, and Europe
would have in the next decade.

As a response to the increasing concerns over the encroachment of
Japanese competition, five chip company executives¾Wilfred
Corrigan (Fairchild), Bob Noyce (Intel), Jerry Sanders (Advanced Micro
Devices), Charles Sporck (National Semiconductor), and John Welty
(Motorola)¾met in early
1977. Above all, these executives expressed frustration at their
companies’ inability to penetrate the Japanese market. Although each
company had formed joint ventures, opened sales and applications offices
in Japan, and attempted to woo Japanese customers, they found it
virtually impossible to increase their share of the Japanese market. At
the same time, Japanese chip companies were selling to American
electronics companies at a greater rate than ever before. The five
semiconductor company executives believed that the success of the
Japanese companies in the United States might be the result of dumping¾selling
devices at less than their production cost. As they viewed their
options, one possibility appeared to be in their collective interests:
the formation of a trade association that would provide them the means
to pursue their concerns about Japanese competition while sharing the
costs and influence that each could bring to bear.

In March 1977, the group formed the Semiconductor Industry
Association (SIA) with John Welty as chairman. When they met, they
reviewed the recent industry market experience with regard to Japanese
competition and felt the need to take immediate action. The first action
they decided on was to establish and maintain an industry database
system to track shipments and orders. That would provide evidence of
their complaints. Second, they set up a smaller group to study the
options open to them to counter Japan’s alleged anti-competitive
practices of dumping their products in the world market while
maintaining a closed market at home.

The newly appointed SIA subgroup was called the
International Trade Committee (later known as the Public Policy
Committee). It was initially led by Bob Noyce (Intel) and later by
George Scalise of Advanced Micro Devices (AMD). The committee consisted
primarily of executives from the larger chip firms, each one with
limited experience in dealing with international trade matters or the
related legal and political actions that could be taken. The broad array
of options that the executives considered ranged from asking the federal
government to stop all imports of Japanese chips to the other extreme¾attempting
to find some acceptable direct nongovernment accommodation with the
Japanese firms. Because of limited experience and lack of unanimity¾the SIA
board of directors engaged a well respected Washington attorney, Alan
Wolff, a former deputy ambassador at the Office of the United States
Trade Representative (USTR), as SIA’s lead counselor. Wolff and his
law firm immediately undertook a study of Japanese marketing practices,
began to update U.S. government leaders, and finally communicated to
Japanese officials that the U.S. industry would pursue political and
legal actions against Japanese firms if market abuses were not
corrected. As a result of this activity and following the suggestion of
Ministry of International Trade and Industry (MITI) Minister Abe, a high
technology working group (HTWG), was formed, consisting of
representatives from Ministry of International Trade and Industry MITI
(Japan), the U.S. Department of Commerce (DOC), and the USTR.

A meeting of the HTWG government officials was held
in Hawaii, during which both sides had access to industry
representatives. By November 1982, an HTWG agreement was drawn up.
Finally, in February 1983, a letter of agreement was signed by both
sides. The HTWG agreement was framed to eliminate the tariffs on chips
imported into either country; remove Japanese impediments to trade and
investment by foreigners; strengthen intellectual property laws and
their enforcement in Japan; and provide an early warning device for
dumping practices by Japanese firms. The HTWG agreement, in principle,
appeared to closely meet the objectives of U.S. industry and to indicate
the willingness of the Japanese industry to comply. The agreement had no
specific or numerical measurements of results nor did it have penalties
or incentives to motivate the participants.

The SIA board of directors accepted the agreement
as a possible solution but did not place their entire faith in it. Using
national security and economic arguments as the basis of its appeal, the
SIA board continued to complain to various branches and agencies in the
U.S. government about unfair Japanese trade practices. The board also
pursued a sui generis intellectual
property bill, which became law in 1984, protecting the topographic
design of integrated circuits; it established a Semiconductor Research
Corporation to provide funds for basic research and training of
engineers and scientists; it created an SIA chapter in Japan for U.S.
subsidiary company executives to unify industry efforts in Japan; it
improved its communications with its computer systems customers in the
United States, who also bought a significant number of chips from
Japanese companies; and it attempted to convince the semiconductor
production equipment industry to join its alliance against unfair
Japanese trading practices, even though these companies were also major
suppliers of materials and capital equipment to Japanese chip makers.

The Japanese companies argued during the same
period that although they were in agreement with the HTWG principles,
their increasing penetration of the U.S. and world marketplaces was not
due to unfair practices but rather to their higher chip quality, greater
efficiency, lower costs, and higher investments in applied research and
manufacturing facilities. The Japanese firms also stated that any
shortfall in the U.S. market share in Japan was the result of a lack of
U.S. company efforts and to the unique characteristics of the Japanese
market for semiconductors.

These differences in American and Japanese views of the
marketplace put the two nations’ industries on a collision course.

II.
Looking Back: The Evolution of a Global High Technology Industry and
the Roots of Conflict

Strife between nations rarely occurs without
reason; indeed, conflict has many origins and the friction that led up
to the conclusion of the U.S.-Japan Semiconductor Agreements is no
exception. The agreements are very much the product of differences
between the political and economic development of the two nations. This
section of Case A will highlight how the semiconductor industry emerged
in the three most advanced economies of the world¾the United
States, Japan, and the European Union¾and how differences in the developmental strategies
employed in these economies led to political tension between the United
States and Japan as competition heated up and national markets began to
merge.

The invention of the transistor at Bell Telephone
Laboratories (BTL) in 1948 signaled the beginning of a revolution in
electronics and the start of a semiconductor industry. The industry
produces semiconductor devices¾transistors, memories, microprocessors, and logic
circuits. Although also popularly know as “computer chips,” for
their common usage in computer hardware industry, all electronic
equipment in fact uses these silicon-based components.

In the years from 1948 to 1958, from the discovery
of the transistor to the invention of the integrated circuit, the
emergence of semiconductor technology and the subsequent growth in
production of chips were affected by two major forces; the U.S.
Department of Defense (DOD), and American Telephone and Telegraph
Corporation (AT&T) through its Bell Telephone Laboratories and its
manufacturing arm, Western Electric. Initially, large established U.S.
firms such as General Electric and RCA were the main benefactors from
the development and diffusion of semiconductor technology. But by the
end of the 1950s, a $300 million production level lured smaller
entrepreneurial firms, namely, Texas Instruments, Motorola, and
Fairchild, into the business. Toward the end the 1960s and the beginning
of the 1970s, other present-day U.S. industry leaders, like Intel,
Advanced Micro Devices (AMD), and National Semiconductor, began to
emerge.

Whilethese
firms sold products in the open merchant market, a parallel course of
internal production and use was developed by AT&T, International
Business Machines, Hewlett Packard, and Digital Equipment Corporation.
The combined output of these in-house producers was estimated to be as
much as 25% of all U.S. production. These internal production operations
were captive chip manufacturers and subsequently called “captives.”

By 1970, the total world market was well over $1
billion and countries besides the U.S. commenced development of their
own semiconductor industries. In Europe, the large electrical and
electronics firms such as Philips (Holland), Siemens (Germany), and SGS-Thomson
(France and Italy), strongly supported R&D and chip production.
Presently, these European manufacturers of semiconductors rank among the
top 25 producers of chips in the world. While the rise of European firms
is certainly notable, the greatest advances in production and increase
of shipments of semiconductors during the early 1970s were made by
Japanese firms: NEC, Hitachi, Toshiba, Fujitsu, Mitsubishi, Matsushita,
and Oki, as well as other smaller, specialized producers.

The
United States to 1977

In the early years, the U.S. industry was supported
by a reliable defense industry market and development funds from the
DOD. But by the late 1960s, the demand for semiconductors shifted from
military applications to commercial use by manufacturers of computers,
consumer electronic products, and industrial equipment. As the industry
refined its design and manufacturing methods, more complex devices were
produced at dramatically lower costs each year. At the time,
conventional wisdom asserted that chip prices would fall by 30% for
every doubling of unit volume, and unit volume was growing at rates as
high as 50% per year.

By the late 1960s, dynamic random access memories (DRAMs)
were the cutting edge “technology drivers” of the times. Large
investments in R&D and capital equipment, which led to rapid
improvements in design, volume, and costs, allowed firms to achieve
continually greater economies of scale and scope. Expenditures for
R&D and capital equipment purchases together accounted for
approximately 25% of annual revenue, a level that was among the highest
of all U.S. manufacturing industries. However, despite high industry
growth rates averaging around 15% per year, the industry was plagued by
lumpy investment patterns, which produced booms and busts in the market.
These chronic shifts in the supply and demand of chips resulted in sharp
annual growth followed by steep declines (all occurring over a three- to
five-year period), becoming known to market observers as the “silicon
cycle.”

Much
of the initial success of U.S. firms can be attributed to both the
DOD’s commitment to funding R&D and thenation’s pool of engineering and scientific talent. As time
progressed, the U.S. industry benefited from expanded access to vast
amounts of venture capital. A large amount of this capital was used by
entrepreneurial semiconductor engineers and managers who had left larger
U.S. companies to start up their own firms. Many of these new firms
located their headquarters and research and development (R&D)
centers in the greater San Jose metropolitan area. Thus, this region of
California (Santa Clara County) became known as “Silicon Valley.”

In the global market, the U.S. maintained a trade
surplus in semiconductors. Its firms possessed major investments in
fabrication and assembly facilities in Europe and low-level assembly
plants throughout the developing nations of Asia, where labor costs were
low. There were also U.S. semiconductor operations in Japan; however,
due to that nation’s restrictions on foreign direct investment, the
U.S. presence there was minimal.

By the end of the 1970s, the U.S. industry
controlled 80% of the world semiconductor market. Despite the high cost
of capital equipment and R&D expenditures, U.S. firms dominated the
industry. Growth was fueled further by a high level of demand from
abroad and by rapid reductions in the costs and prices of devices as
their complexity and applicability increased.

Europe to 1977

Whereas the U.S. semiconductor industry was
established by entrepreneurial firms funded with venture capital, the
European approach to the development of a semiconductor industry was to
place its trust in large corporations, namely, Philips, Siemens, SGS (at
that time Italy), and Thomson (at that time France). Government policies
also encouraged foreign (non-European) firms to invest directly in
Europe rather than simply exporting their products to European
customers. The European Community’s (EC) strategy was to establish a
European production base, regardless of ownership of the facilities.
European-based firms as well as American and Japanese semiconductor
subsidiaries were protected and supported in several ways: rules of
origin, which blocked the use of imported semiconductors; tariffs as
high as 17%; preferential procurement practices; and R&D support
through European consortia and cooperatives. The weaknesses of the EC
strategy were that it tended to rely on fragmented national markets
rather than international ones; its failure to recognize the needs of
domestic users of semiconductor chips such as the computer industry; and
its failure to promote the development of indigenous skills to
manufacture integrated circuits in high volume.

Japan
to 1977

The Japanese semiconductor industry began with
infant-industry protection; a successful commercial industry take-off;
the promotion of an efficient and effective number of keiretsu-affiliated semiconductor companies; and a high degree of
success in foreign markets. The Japanese government rejected almost all
applications for wholly owned foreign subsidiaries and instead allowed
only joint ventures; restricted foreign purchases of semiconductors;
kept high tariffs and low quotas; and reviewed all requests for
assistance and licensing agreements. At first the Ministry of
International Trade and Industry (MITI) controlled and then guided the
diffusion of foreign technology to Japanese firms. Although U.S. firms
held almost 80% of the U.S. market and 60% of the European market,
toward the end of the 1970s foreign firms (primarily U.S. and European
firms) held only a 10% share of the Japanese market.

As Japanese firms began to specialize in
manufacturing efforts on devices for consumer electronics in the mid
1960s, the Japanese government slowly began to ease formal barriers to
trade and foreign investment. Ironically, however, as Japanese firms
increasingly became exposed to foreign competition at home, MITI began
to promote cooperation in technological development among national
firms. Prior to this period Japan lagged behind in research and
development of new semiconductor products. But by sponsoring joint
R&D projects and encouraging the rationalization of production, MITI
took it upon itself to promote innovation.

In spite of the easing of restrictions, only six Japanese firms
dominated the semiconductor market in Japan, controlling 80% of the
market. These firms were all directly associated with vertically
integrated keiretsu combinations
which some foreign observers believed had led to a cartelization of the
market. These alleged anti-competitive trading practices were believed
to be restricting all but the most advanced foreign products from
entering the Japanese market. Foreign shares in Japan were held to 10%
despite the apparent technological superiority and lower device cost of
non-Japanese firms. In addition, foreign firms claimed that the Japanese
companies had unfair access to subsidized investment capital, which
allowed them to maintain their growth, even during the down cycle of
world semiconductor industry markets.

III.
Heading Toward Conflict

Keeping in mind the origin of the friction between
the semiconductor industries of U.S. and Japan, these two countries
attempted to implement resolutions concluded by the High Technology
Working Group.

The HTWG agreement seemed to be a foundation to
build on. However, both industries¾the SIA through its board and its members (which
now numbered over 30, including the captive chip divisions of IBM, HP,
DEC, and AT&T) and the Electronic Industries Association of Japan (EIAJ),
representing the Japanese chip makers¾continued attempts to influence American government
and private interests. However, market forces during the next two years
soon brought about a widening of the gap, which separated the interests
of the two nations.

In 1984, the year after the HTWG agreement was
signed, the world’s chip industry grew dramatically¾46% over the previous year. The boom appeared to
lessen tensions to some degree and most of the world’s chip makers
appeared to be performing relatively well. Only one U.S. firm, the
Mostek Corporation (a major producer of DRAMs) believed that dumping had
not ceased. Most SIA members felt not only that U.S. firms were doing
well overall, but also that the industry’s political influence was
improving. The events of 1985 were to emphasize, however, that the good
times were only temporary.

In 1985, the world chip market was rapidly eroded
by a recession. When the final numbers for the year were in, the
industry had declined globally over 17% from the previous year. The U.S.
market was up 24% in 1983, up 49% in 1984, but down 30% in 1985. A large
number of American firms were unprofitable and in danger of failing.
Many of them were forced to withdraw from the DRAM market, which now
became the principal market for the Japanese firms. The U.S. competitors
accused Japanese firms of dumping memory chips, but their U.S. customers
defended them as higher-quality, lower-cost suppliers. In fact,
Hewlett-Packard executives stated publicly that Japanese chips had only
one-tenth the level of defects of U.S. chips.

Accusations were strident, and the earlier
agreements of the HTWG were virtually dismissed by SIA as empty
promises. By spring 1985, the U.S. chip industry believed that it would
be annihilated by the Japanese competition unless quick and drastic
action was taken. At the SIA board meeting in early 1985, the public
policy committee headed by George Scalise (AMD) and the board of
directors chaired by Gary Tooker (Motorola) struggled with the question
of how far and how fast members of the U.S. industry should act to
change the existing state of affairs. Before any action could be taken,
however, leaders in the U.S. semiconductor industry had to reach a
consensus among the different interests represented by the SIA. Each
company had different relations with Japanese firms, which could
possibly be adversely affected if a dumping suit against Japan were
initiated. After a vigorous discussion leading to unanimity among the
corporate chief executives, the U.S. industry decided to act
aggressively.

On June 14, 1985, the SIA filed a trade action
petition USTR under Section 301 of the Trade Act, stating its
complaints. A week later, Micron Technology, a prominent U.S. DRAM maker
and one of the few nonmembers of SIA, filed a separate 64K DRAM dumping
suit with the Department of Commerce. By October 1985, Intel, National
Semiconductor, and Advanced Micro Devices filed an EPROM (another form
of memory) dumping suit with the Department of Commerce. In December,
the DOC self-initiated a 256K DRAM dumping case. It appeared that an
avalanche of political and legal activity against Japan had begun.

The SIA moved to consolidate its position with
other American electronic industry interests as well as any U.S.
government officials that were not in accord with its actions.
Furthermore, the SIA also met in California with representatives of the
European chip makers¾Philips, SGS-Thomson,
and Siemens¾in
an attempt to convince them to support the SIA and U.S. government
actions. The Europeans’ position was follows: The United States would
be ultimately unsuccessful in opening the Japan market; therefore, they
saw no value in fighting a losing market access battle. Second, they
were initiating their own dumping suit against Japan. And furthermore,
they implied they might initiate a dumping suit against the Americans!
Most surprising, they tentatively stated that the United States should
give up a share of the European market to them on an agreed upon basis,
in an informal market sharing agreement. Obviously, the SIA was
unwilling to accept any of the European positions, but it did promise to
keep the Europeans informed of further American actions.

Since the SIA had filed the complaint with USTR in
summer 1985, Japan had one year¾until July 1986¾to agree to terms with the United States or
then-President Reagan could retaliate against Japan as he saw fit. By
January 1986, Japanese industry was seeking some way to avoid
presidential action. One more attempt was made by the U.S. and Japanese
industries- to stave off government action. Akio Morita, chairman of
Sony Corporation (Japan) and Bob Galvin, chairman of Motorola (U.S.A.),
agreed to hold an industry-to-industry meeting in Los Angeles in March
1986. Key members of the Japanese and American industries and their
attorneys attended, as did Japanese government representatives.

During this meeting, MITI indicated that it would
encourage the traditional “top 5”Japanese firms, representing
30%-35% of the Japanese market, to increase their foreign semiconductor
content from 13% to 20%¾this would
be the model for other Japanese firms over the next five years. In
subsequent negotiation sessions, MITI offered to impose a uniform floor
price to settle the dumping suits, but the United States rejected these
offers because they would allow inefficient Japanese firms to dump down
to the uniform floor price and would prevent the efficient Japanese
firms from pricing below the floor.

No U.S. government officials attended these
meetings. The outcomes, although not definitive, were provided to the
Japanese and U.S. government officials negotiating the Section 301
action. As the summer drew near and the July 31 deadline loomed closer,
the SIA faced a number of questions on which its success in the 301
negotiations hinged. The questions that the SIA board faced were the
following:

Should the European Economic Community be left out
of the agreement? Should SIA accept 20% share of market from only the
top 10 Japanese firms? What actions must the Japanese industry and the
government of Japan take to satisfy the U.S. chip industry? How could
these actions be taken so that other domestic interests¾chip customers, chip manufacturing equipment
suppliers, can be satisfied? Should the U.S. agree to uniform worldwide
floor prices as preferable to imposing dumping duties by individual
Japanese companies? Which actions would not negatively impact the other
nations’ industry? How far was the U.S. government willing to go to
obtain the U.S. chip industry’s goals?

In
order to help you answer these questions, the following exhibits are
given with Case A.